Hard Issues To Consider in Business Valuation Engagements. Texas Society of Certified Public Accountants 27 th Annual CPE Tax Expo January 10, 2017

Transcription

1 Hard Issues To Consider in Business Valuation Engagements Texas Society of Certified Public Accountants 27 th Annual CPE Tax Expo January 10, 2017 Presented by: J. Richard Claywell, CPA, ABV, ASA, CBA, ICVS, CVA, CM&AA, MAFF, CFD, ABAR

2 J. Richard Claywell, CPA, ABV, ASA, CBA, CVA, CM&AA, MAFF, CFD, ABAR Certified Public Accountant (CPA) Accredited in Business Valuation (ABV) American Institute of Certified Public Accountants Accredited Senior Appraiser in Business Valuations (ASA) American Society of Appraisers 2

3 J. Richard Claywell, CPA, ABV, ASA, CBA, CVA, CM&AA, MAFF, CFD, ABAR 3 Certified Business Appraiser (CBA) Institute of Business Appraisers Certified Valuation Analyst (CVA) National Association of Certified Valuation Analysts Certified Merger & Acquisition Advisor (CM&AA) Alliance of Merger and Acquisition Advisors

4 J. Richard Claywell, CPA, ABV, ASA, CBA, CVA, CM&AA, MAFF, CFD, ABAR 4 Master Analyst in Financial Forensics (MAFF) - National Association of Certified Valuation Analysts Certified in Fraud Deterrence (CFD) International Association of Consultants Valuators and Analysts Accredited in Business Appraisal Review (ABAR)

5 Hard Issues to Consider in Business Valuation Engagements 5 Engagement Letters Getting the entire agreement Indemnification Getting document from document request Client indicates they do not have documents when you know they do have them Requesting documents multiple times

6 Hard Issues to Consider in Business Valuation Engagements 6 Adjusted Book Value Adjust Assets to Fair Market Value Adjusting Accounts Receivable to Fair Market Value What is the inventory pricing method If Lower of Cost or Market, provide analysis How to value marketable securities

7 Hard Issues to Consider in Business Valuation Engagements 7 Adjusted Book Value Adjust Assets to Fair Market Value Getting appraisals for real and personal property Property tax assessments Adjust Liabilities to Fair Market Value

8 Adjusted Net Assets 8 Historical Fair Market Value Fair Market Source For The Period Ending Cost Adjustments Value Prior Percentage Date of 12/31/2010 or Basis Adj # Amount to Discounts Investment Appraised Appraised Value Assets Current Assets Accounts Receivable (net) 1,479, ,479, % Adjust accounts receivables to net realizable value Inventory 4,028, ,028, % Adjust inventory for LIFO Reserve Account Receivable - Related Parties 1,100, ,100, % Prepaid Expenses 71, , % Total Current Assets 6,679,214 6,679, % Fixed Assets Furniture & Fixtures 111, , % Equipment 1,091, ,091, % Computers Aids for Industrial Productivity (CAIP) 121, , % Software % Vehicles 118, , % Total Fixed Assets 1,443, ,443, % Less Accumulated Depreciation (919,795) 3 919, % 12/31/01 Remove accumulated depreciation Net Fixed Assets 523,673 1,443, % Other Assets Other Assets 643, , % Total Other Assets 643, , % Total Assets 7,845,976 8,765, % ============ ============ ============ Assets should be adjusted to Fair Market Value Accumulated Depreciation MUST be zero

9 Adjusted Net Assets 9 Historical Fair Market Value Fair Market Source For The Period Ending Cost Adjustments Value Prior Percentage Date of 12/31/2010 or Basis Adj # Amount to Discounts Investment Appraised Appraised Value Liabilities & Stockholder's Equity Current Liabilities Accounts Payable 741, , % Accounts Payable to Related Parties 76, , % Accrued Expenses 330, , % Checks in Excess of Bank 152, , % Line of Credit 1,419, ,419, % Income and Other Taxes Payable (23,390) 0 (23,390) -0.3% Customer Deposits Payable 185, , % Total Current Liabilities 2,882,648 2,882, % Long-Term Liabilities Notes Payable to Various Banks 3,281, ,281, % Total Long-Term Liabilities 3,281,742 3,281, % Long-Term Debt MUST be adjusted to Fair Market Value Total Liabilities 6,164,390 6,164, % Members' Equity Member - S. Smith, Revocable 35% 621, , , % Member - K. Smith, Revocable 30% 533, , , % Member - J. 25% 444, , , % Member - L. 5% 88, , , % Member - M. 5% 88, , , % Net Income (95,529) 0 (95,529) -1.1% Total Equity 1,681,586 2,601, % Total Liability & Equity 7,845,976 8,765, % ============ ============ ============

10 Hard Issues to Consider in Business Valuation Engagements Market Approach Public company data 10 (Comparability) Company capital structure Company credit status Depth of management Experience level of management Nature of competition Company size Respective products

11 Hard Issues to Consider in Business Valuation Engagements Market Approach Public company data 11 (Comparability) Ratio of net earnings and other ratios Dividend paying capacity Book value

12 Hard Issues to Consider in Business Valuation Engagements 12 Market Approach Position in the industry Public company data (Comparability) Review analysis for skewness Review analysis for kurtosis

13 Hard Issues to Consider in Business Valuation Engagements 13 Comparability Factors ATEC HRC IART NUVA PDEX SYK TSON EXAC MAKO RTIX SNN WMGI ZMH OFIX ARTC BMET BMET ENMC EYE NAVB Size Sales No No No No No No No No Yes No No No No No No No No No No Yes Employees No No No No No No No No No No No No No No No No No No No No Entity Type Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Management Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Geographic Areas Served No No No No No No No No No No No No No No No No No No No No Growth One Year Sales Growth Percentage No No No No No No No No No No No No No No No Yes Yes Yes Yes No Three Year Sales Growth Percentage No No No No No No No No Yes No No No No No No Yes Yes Yes Yes No Liquidity Current Ratio No No No No No No No No No No No No No No No No No No No No Quick Ratio No No No No No No No No No No No No No No No No No No No No Average Collection Period Yes Yes Yes Yes Yes Yes Yes Yes No Yes No Yes Yes Yes Yes Yes No Yes Yes Yes Profitability Return On Total Assets No No No No No No No No No No No No No No No No No No No No Return On Equity No No No No No No No No No No No No No No No No No No No No Gross Profit Yes Yes Yes Yes No Yes Yes Yes No Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Operating Profit No No No No No No No No No No No No No No No No No No No No Net Profit No No No No No No No No No No No No No No No No No No No No EBITDA % No No No No No No No No No No No No No No No No No No No No Turnover Accounts Receivable Turnover Yes Yes Yes Yes Yes Yes Yes Yes No No Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Inventory Turnover Yes No No No No No Yes Yes Yes Yes Yes Yes Yes No Yes Yes No No No No Fixed Asset Turnover Yes Yes No Yes Yes Yes No Yes No Yes Yes Yes Yes No Yes Yes No Yes Yes No Total Asset Turnover No No No No Yes No No No No No No No No No No No No No No No Working Capital Turnover No No No No No No No No No No No No No No No No No No No No Leverage Total Debt to Total Assets No No No No No No No No No No No No No No No No No No Yes Yes Long-Term Debt to Equity No No No No No No No No No No No No No No No No No No No No Times Interest Earned No No No No No Yes Yes No Yes No No No Yes No No No No No No No BME Attributres Not Comparable to Public Companies BME Attributes Comparble to Public Companies Percentage Comparable based on variance of plue or munus 50% 29.2% 25.0% 20.8% 25.0% 25.0% 29.2% 29.2% 29.2% 21.7% 25.0% 25.0% 29.2% 33.3% 20.8% 29.2% 31.8% 18.2% 27.3% 31.8% 29.2%

14 Hard Issues to Consider in Business Valuation Engagements 14 Market Approach Private Transactions Private company data Identifying the appropriate SIC NAICS Code Review analysis for skewness Review analysis for kurtosis

15 15 Hard Issues to Consider in Business Valuation Engagements 60.0 Distribution of Original Data Used PE Ratio Price Earnings Normal Distribution Actual Distribution

16 PE Ratio 16 Hard Issues to Consider in Business Valuation Engagements 35.0 Distribution After Eliminating Outliers Price to Earnings Actual Distribution

17 17 Hard Issues to Consider in Business Valuation Engagements Market Approach Private Transactions Can calculate the percentage of improvement over using the average of median of original data Test of 2 means

18 18 Hard Issues to Consider in Business Valuation Engagements Market Approach Private Transactions Review for kurtosis

19 Hard Issues to Consider in Business Valuation Engagements 19

20 20 Hard Issues to Consider in Business Valuation Engagements Market Approach Private Transactions Review for kurtosis Eliminate outliers to eliminate kurtosis Back transformations

21 21 Hard Issues to Consider in Business Valuation Engagements Normal Price to Revenues and Earnings to Revenues Analysis Transformed Price to Revenues and Earnings to Revenues Analysis ŷ y - ŷ ( y - ŷ) 2 X (Z Score) ( y - ŷ) 2 If "X" Delete Predicted Sum of Residuals Earnings Standardized Transformed Transformed Predicted Standardized Residuals Exceeds 2.5 Value Residuals Squared Squared Residuals Earnings /Revenues (X) Sales Price / Revenues (Y) Sales Price (Y) Residuals Residuals Squared Standard Deviations (7, ) 57,187, ,500,000,000 (0.4236) , (10, ) (0.5517) 117,934, (11, ) 141,551, ,089,000,000 (0.6665) , (2, ) (0.1115) 4,817, , ,014, ,364,000, , , ,791, , ,627, ,921,000, , , ,922, (22, ) 502,193, ,889,000,000 (1.2554) , (27, ) (1.4094) 769,730, (5, ) 30,033, ,884,000,000 (0.3070) , (7, ) (0.3573) 49,459, , ,242, ,744,000, , , ,078, , ,988, ,084,000, , , ,374, (2, ) 8,101, ,056,000,000 (0.1594) , (5, ) (0.2913) 32,869, , ,301, ,809,000, , , ,290,896, (9, ) 92,447, ,056,000,000 (0.5386) , (12, ) (0.6171) 147,540, (16, ) 272,745, ,225,000,000 (0.9252) , (7, ) (0.3862) 57,782, (19, ) 385,782, ,044,000,000 (1.1003) , (26, ) (1.3393) 695,061, ,505,218, ,665,000, (0.0002) (0.0000) 4,262,259, ============== =============== ============ ============ ============ ========== ================ Normal Price to Revenues and Earnings to Revenues Analysis Transformed Price to Revenues and Earnings to Revenues Analysis Mean of Residuals Mean of Residuals (0.0000) SEE - Standard Error of the Estimate SEE - Standard Error of the Estimate 19, R 2 (Selling Price and Transformed ŷ Predicted Value) R 2 (Selling Price and Transformed ŷ Predicted Value) Coefficient Of Variation 12.74% Coefficient Of Variation 14.05% Indicated Value - Normal Price to Revenues and Earnings to Revenues Indicated Value - Transformed Price to Revenues and Earnings to Revenues Revenues 42,262,526 Revenues 42,262,526 Earnings 14,608,081 Earnings 14,608,081 ŷ Predicted Value Based on Normal Trend 27,346,356 ŷ Predicted Value Based on Transformed Trend 25,920,770 Indicated Value 27,346,000 Indicated Value 25,921,000

22 Hard Issues to Consider in Business Valuation Engagements 22 Income Approach Capitalized Earnings / Cash Flow Discount / Capitalization Rate Build Up Model Capital Asset Pricing Model Weighted Average Cost of Capital Risk Rate Component Model Long-Term Sustainable Growth

23 Hard Issues to Consider in Business Valuation Engagements 23 Adjusted Net Assets Adjust Assets to Fair Market Value Adjust Liabilities to Fair Market Value

24 Hard Issues to Consider in Business Valuation Engagements 24 Marketability Discount Should be based on attributes of the company, not just prior studies Minority Interest Discount Reconciliation of Methods

25 Hard Issues to Consider in Business Valuation Engagements 25 To set the stage for an overall discussion of valuation reviews we will go through several quick examples of flaws and show you how simple it is to use basic knowledge about business valuations to find what is wrong Income Approach Market Approach Cost Approach

26 Income Approach Example 26 There are two methods within the income approach Capitalization of Earnings or Cash Flows Discounted Future Earnings or Cash Flows

27 Two Methods of Income Approach Example Capitalization of Earnings or Cash Flows Single Period method where annual measure is divided by a capitalization rate to give an estimate of value. 27 Instead of forecasting year by year income (as with discounted future income / cash flow), if income is expected to grow at a more or less constant rate, can be simplified to using a capitalization rate.

28 Two Methods of Income Approach Example 28 Discounted Earnings / Cash Flows Income projected / forecasted year by year and brought back to present value today at a discount rate, a rate or return for risk

29 Capitalization of Earnings / Cash Flow 29 Is the Capitalization Rate Reasonable? Formula for the Capitalization of Income / Cash Flow Method Value = Income Stream, Next Year Capitalization rate

30 Capitalization of Earnings / Cash Flow 30 Is the Capitalization Rate Reasonable? A Business Valuation has been performed using the capitalization of earnings method. Your job is to decide if the business valuation seems reasonable.

31 Are the Earnings to be Capitalized Stabilized? Change Weighted Percentage In Year Earnings Weight Value Change Percentage , , , , % , , % 0.0% , ,400, % 11.1% , ,500, % -22.9% Total Weighting 15 4,975,000 ========== Divide by Weighting Weighted Average Estimated Value 331,667 ============ 31

32 Are the Earnings to be Capitalized Weighted Year Earnings Weight Value , , , , , , , ,400, , ,500, Future Years Total Weighting 15 4,975,000 ============= Divide by Weighting Weighted Average Estimated Value 331,667 =========== Stabilized? Earnings are Weighted Increasingly by Year 600, , , , , ,000 0 Capitalized Earnings - Weighting the Years Increasing Earnings Capitalized Earnings Earnings Used 32 Assumed Capitalization Rate 10% Preliminary Value 3,316,667

33 Are the Earnings to be Capitalized Stabilized? 33 Earnings are Weighted Decreasing by Year Weighted Year Earnings Weight Value , , , , , , , , , , Future Years Total Weighting 15 2,975,000 ============= Divide by Weighting Weighted Average Estimated Value 198,333 =========== 600, , , , , ,000 0 Capitalized Earnings - Weighting the Years Decreasing Earnings Capitalized Earnings Earnings Used Assumed Capitalization Rate 10% Preliminary Value 1,983,333

34 Are the Earnings to be Capitalized Stabilized? 34 Earnings are Weighted Equally by Year Weighted Year Earnings Weight Value , , , , , , , , , , Future Years Total Weighting 5 1,325,000 =============== Divide by Weighting Weighted Average Estimated Value 265,000 =========== 600, , , , , ,000 0 Capitalized Earnings - Weighting the Years Equally Earnings Capitalized Earnings Earnings Used Assumed Capitalization Rate 10% Preliminary Value 2,650,000

35 Is the Capitalization Rate Reasonable? 35 Preliminary Values Method Value Payback in Years Earnings are Weighted Increasingly by Year 3,316, Earnings are Weighted Decreasing by Year 1,983, Earnings are Weighted Equally by Year 2,650,000 10

36 Is the Capitalization Rate Reasonable? 36 Is anything wrong with the Capitalization rate Begin by understanding what makes up the capitalization rate and breaking it down into its components This provides the clues

37 Is the Capitalization Rate Reasonable? 37 Build Up Method: Source - Moriningstar Duff and Phelps Valuation Handbook Risk-Free Rate 2.60% K-T 20 Year US Treasury Equity Risk Premium 6.07% Large Company Stock Returns Less Govt Bond Returns Size Premium 5.60% 10th Decile Company Specific Risk 2.00% Valuator's judgment Discount Rate 16.27% Less: Long-term Sustainable Growth 6.00% Capitalization Rate 10.27% ======= Capitalization Rate (rounded) 10.00% =======

38 Is the Capitalization Rate Reasonable? 38 The capitalization rate is affected by risk (through the discount rate) and growth The higher the discount / capitalization rate, the LOWER the value The lower the discount / capitalization rate, the HIGHER the value.

39 Is the Capitalization Rate Reasonable? 39 Focus first on the discount rate (rate of return for risk) Hard to argue with the industry data used by the expert.

40 Is the Capitalization Rate Reasonable? 40 What about the company specific risk? Does the company specific risk capture the extra risk of the company? Small capitalized company would be approximately 15% Bottom line, the expert s company specific risk is too low

41 Is the Capitalization Rate Reasonable? 41 Assume the company specific risk should be 6% What about the long-term sustainable growth?

42 Is the Capitalization Rate Reasonable? 42 What about the long-term sustainable growth? Is the 6% expected future growth rate too high, too low, or just right? Inflation from 1929 to 2015 was 3.1%.

43 Is the Capitalization Rate Reasonable? 43 Original and Corrected for Flaws in Risk and Growth Build Up Method: Source - Moriningstar Duff and Phelps Valuation Handbook Risk-Free Rate 2.60% 2.60% K-T 20 Year US Treasury Equity Risk Premium 6.07% 6.07% Large Company Stock Returns Less Govt Bond Returns Size Premium 5.60% 5.60% 10th Decile Company Specific Risk 2.00% 8.00% Valuator's judgment Discount Rate 16.27% 22.27% Less: Long-term Sustainable Growth 6.00% 2.00% Capitalization Rate 10.27% 20.27% ======= ======= Capitalization Rate (rounded) 10.00% 20.00% ======= =======

44 Is the Capitalization Rate Reasonable? What a Big Difference Just a Little Sound Thought and Logic Make Weighted Weigthted Corrected Earnings Value at 20% Difference Earnings are Weighted Increasingly by Year 331,667 3,316,667 1,658,334 1,658,334 Earnings are Weighted Decreasing by Year 198,333 1,983, , ,667 Earnings are Weighted Equally by Year 265,000 2,650,000 1,325,000 1,325, Difference is the amount over valued

45 Is the Capitalization Rate Reasonable? 45 A company with high growth or low growth is a situation best suited to the discounted future earnings / cash flows method, where the year by year forecast is taken into account

46 Discounted Future Earnings / Cash Flow Method Method used when historical earnings / cash flows are not stabilized 46 Method best captures value when a company is expected to have very high growth rates over the next few years, then slow to a more mature rate of increase It is widely used by acquirers

47 Discounted Future Earnings / Cash Flow Method How do you review? 47 Test every revenue and expense assumption

48 Discounted Future Earnings / Cash Flow Method Test projection / forecast in light of 48 Actual historical experience Commonsense about what you think might drive the business How others in the industry perform

49 Discounted Future Earnings / Cash Flow 49 An Example We will look at a spreadsheet for a Discounted Cash Flow Examine the simplicity of how the Discounted Cash Flow works Critique the Discounted Cash Flow and its assumptions and findings using common sense

50 Discounted Future Earnings / Cash Flow 50 An Example I will tell you the changes to be made and see how they impact value

51 Discounted Cash Flow 51 Base Year Terminal Projected Discounted Cash Flows Value Net Revenues 24,124,811 20,717,282 30,800,000 47,250,000 62,790,000 83,401, % 53.4% 32.9% 32.8% Adjusted Pre-Tax Income 1,083,728 1,325,305 3,585,931 5,561,814 8,483,515 Pre-Tax Profit Margin 4.3% 7.6% 8.9% 10.2% Income Tax 37.5% (406,398) (496,989) (1,344,724) (2,085,680) (3,181,318) After Tax Income 677, ,316 2,241,207 3,476,134 5,302,197 Net Profit Margin (for full years) 2.7% 4.7% 5.5% 6.4% Add Depreciation and Amortization 197, , , , , Gross Cash Flow 874,614 1,127,925 2,571,852 3,861,174 5,733,352 Interest Expense 201, , , , ,008 Debt Free Working Capital Requirements (7% of annual sales-rounded) (128,000) (283,000) (1,152,000) (1,088,000) (1,443,000) Capital Expenditures (200,000) (200,000) (1,750,000) (1,000,000) (200,000) Net Cash Flows to Invested Capital 748, ,425 (34,835) 2,126,368 4,507,360 ============== ============= ============= ============ ============= Discount Term (mid-term Convention) Number of years of projected net income 5 Net Cash Flow Discount Rate 22.19% Present Value Factor Present Value of Discounted Net Operating Cash Flow to Equity (rounded) 694, ,000 (22,000) 1,109,000 1,923,000 Final Year Value 4,507,360 Long-Term Growth Rate Terminal Value based on long-term sustainable growth 5.0% Terminal Value 4,732,728 Capitalization Rate Common error in terminal value calculation(n+1) 17.2% Capitalized Value 27,531,867 Present Value Factor Present Value of Terminal Value 9,614,000 ============= Total of Net Present Values 13,970,000 Debt as of the Valuation Date (4,700,931) Value of 100% of Equity 9,269,069 ============== Value based on terminal year not being stabalized

52 Discounted Cash Flow 52 Base Year Terminal Projected Discounted Cash Flows Value Net Revenues 24,124,811 20,717,282 30,800,000 47,250,000 62,790,000 83,401,500 87,571, % 53.4% 32.9% 32.8% Adjusted Pre-Tax Income 1,083,728 1,325,305 3,585,931 5,561,814 8,483,515 8,907,691 Pre-Tax Profit Margin 4.3% 7.6% 8.9% 10.2% 10.2% Income Tax 37.5% (406,398) (496,989) (1,344,724) (2,085,680) (3,181,318) (3,340,384) After Tax Income Notice change in final year 677, ,316 2,241,207 3,476,134 5,302,197 5,567,307 Net Profit Margin (for full years) 2.7% 4.7% 5.5% 6.4% 6.4% Add Depreciation and Amortization 197, , , , , , Gross Cash Flow 874,614 1,127,925 2,571,852 3,861,174 5,733,352 6,020,019 Interest Expense 201, , , , , ,858 Debt Free Working Capital Requirements (7% of annual sales-rounded) (128,000) (706,000) (1,152,000) (1,088,000) (1,443,000) (208,504) Capital Expenditures (200,000) (200,000) (1,750,000) (1,000,000) (200,000) (210,000) Net Cash Flows to Invested Capital 748, ,425 (34,835) 2,126,368 4,507,360 6,039,374 ============== ============= ============= ============ ============= ============= Discount Term (mid-term Convention) Number of years of projected net income 5 Net Cash Flow Discount Rate 22.19% Present Value Factor Present Value of Discounted Net Operating Cash Flow to Equity (rounded) 694, ,000 (22,000) 1,109,000 1,923,000 Long-Term Growth Rate 5.0% Change is working Terminal Value capital should be 6,039,374 Capitalization Rate based on NET Based on long-term sustainable 17.2% changes in working growth capital, NOT based Capitalized Value 35,133,066 on a percentage of Present Value Factor changes in revenues Present Value of Terminal Value 14,991,000 ============= Total of Net Present Values 19,018,000 Debt as of the Valuation Date (4,700,931) Value of 100% of Equity 14,317,069 ============== Value based on terminal year being stabalized

53 Discounted Cash Flow 53 Base Year Projected Discounted Cash Flows Terminal Net Revenues 24,124,811 20,717,282 30,800,000 47,250,000 62,790,000 83,401,500 87,571, % 53.4% 32.9% 32.8% Adjusted Pre-Tax Income 1,083,728 1,325,305 3,585,931 5,561,814 8,483,515 8,907,691 Pre-Tax Profit Margin 4.3% 7.6% 8.9% 10.2% 10.2% Income Tax 37.5% (406,398) (496,989) (1,344,724) (2,085,680) (3,181,318) (3,340,384) After Tax Income 677, ,316 2,241,207 3,476,134 5,302,197 5,567,307 Net Profit Margin (for full years) 2.7% 4.7% 5.5% 6.4% 6.4% Add Depreciation and Amortization 197, , , , , , Gross Cash Flow 874,614 1,127,925 2,571,852 3,861,174 5,733,352 6,020,019 Interest Expense 201, , , , , ,858 Debt Free Working Capital Requirements (7% of annual sales-rounded) (128,000) (706,000) (1,152,000) (1,088,000) (1,443,000) (208,504) Capital Expenditures (200,000) (200,000) (1,750,000) (1,000,000) (200,000) (210,000) Net Cash Flows to Invested Capital 748, ,425 (34,835) 2,126,368 4,507,360 6,039,374 ============== ============= ============= ============ ============= ============= Discount Term (Mid-Term Convention) Number of years of projected net income 5 Net Cash Flow Discount Rate 22.19% Present Value Factor Present Value of Discounted Net Operating Cash Flow to Equity (rounded) 694, ,000 (22,000) 1,109,000 1,923,000 Long-Term Growth Rate 5.0% Terminal Value 6,039,374 Capitalization Rate Depreciation expense CANNOT exceed Capital Expernditures in 17.2% Capitalized Value the Terminal year. 35,133,066 Present Value Factor Present Value of Terminal Value 14,991,000 ============= Total of Net Present Values 19,018,000 Debt as of the Valuation Date (4,700,931) Value of 100% of Equity 14,317,069 ==============

54 Discounted Cash Flow 54 Working Capital Metric Calculation Working Capital Metric Calculation Revenues 2,000,000 2,400,000 2,150,000 2,475,000 2,825,000 Working Capital - Including Cash 395, , , ,380 1,168,517 Working Capital to Revenues Working Capital - Excluding Cash 128, , , , ,719 Working Capital Excluding Cash to Revenues Working Capital Needs Analysis Working capital analysis Projected Revenues INCLUDING cash - 2,825,000 Growth Accounting Concept 5.0% Projected Revenues 2,966,250 Times Working Capital Percentage Working capital analysis 0.41 Estimated Working Needs EXCLUDING cash Valuation/Appraisal 1,226,943 concept ======== Projected Revenues 2,966,250 Times Working Capital Percentage Estimated Working Needs 189,755 ======== This is for demonstration purposes only. The remainder of the analysis has not been completed.

55 Speaker Biography 55 J. Richard Claywell CPA, ABV, ASA, CBA, CVA, CM&AA, CFD, MAFF, ABAR, CMEA Certified Public Accountant, Accredited in Business Valuations, Accredited Senior Appraiser, Certified Business Appraiser, Certified Valuation Analyst, Certified Mergers and Acquisitions, Advisor, Certified in Fraud Deterrence, Master Analyst in Financial Forensics, Accredited in Business Appraisal Review, Certified Machinery and Equipment Appraiser Richard is one of approximately 20 professionals that holds all four business valuations from the recognized business valuation organizations in the US. Richard s practice is limited to valuing closely held businesses, litigation support, economic damages, and exit planning. Richard has been working in the area of business valuations and exit planning since 1985 and has prepared over nine hundred valuations reports.

56 Speaker Biography J. Richard Claywell CPA, ABV, ASA, CBA, CVA, CM&AA, CFD, MAFF, ABAR, CMEA 56 Richard is on the Board of Directors and is the Director of Education for the International Association of Consultants, Valuators and Advisors. He is responsible for all global educational materials related to business valuations. The International Association of Consultants, Valuators and Analysts (IACVA), is a 10,000 member organization with business valuation designation-granting authority in 55 countries. Richard wrote a chapter for the Guide to International Valuation Handbook on Valuing Oil and Gas Interests and Developing Discount and Capitalization Rates. Richard taught a two day course on valuing intangibles in Beijing China in November 2008 a presentation on Financial Fraud at the Taipei World Valuation Conference in Taiwan Taipei in November 2009 and a two day merger and acquisition and one-half day course on financial fraud course at the Shanghai University of Finance and Economics in September 2010.

57 Speaker Biography J. Richard Claywell CPA, ABV, ASA, CBA, CVA, CM&AA, CFD, MAFF, ABAR, CMEA 57 Richard spoke at the 2012 Forensic Accounting Conference - The Risk Assessment and Prevention of Fraud in Business at the National Taipei University on April 27, The presentation was titled The Meaning and Importance of Risk Assessment of and Prevention of Fraud in Businesses. On April 29, 2012 Richard spoke at the Central University of Finance and Economics in Beijing China, presented a class titled Relationships Between Risk and Value in Valuation to graduate students. On April 29, 2012, Richard accepted an appointment to adjunct Professor of Valuation at the Central University of Finance and Economics and Research Fellow of the Appraisal Institute, Asset Appraisal Institute of the Central University of Finance and Economics in Beijing China. Richard was a Contributing Editor to Practitioners Publishing Company (PPC) Guide to Practical Estate Planning, 2008.

58 J. Richard Claywell, CPA Disclaimer 58 The purpose of this presentation is to provide information, rather than advice or opinion. It is accurate to the best of the speaker s knowledge as of the date the presentation was developed. Accordingly, this presentation should not be viewed as a substitute for the guidance and recommendations of a retained professional and should not be construed as legal or other professional advice. J. Richard Claywell recommends consultation with competent legal counsel and/or other professional advisors before applying this material in any particular factual situations. To the extent this presentation contains any examples, please note that they are for illustrative purposes only and any similarity to actual individuals, entities, places or situations is unintentional and purely coincidental. In addition, any examples used are not intended to establish any standards of care, or to serve as legal advice appropriate for any particular factual situations.

59 J. Richard Claywell, CPA

60 J. Richard Claywell, CPA